People often ask me if their Social Security income is taxable. No, sorry, I just lied. When I finish preparing a tax return for someone on Social Security I’ll often hear, “What do you mean my Social Security is taxable? ” People who say that are usually angry when they say it too. But, for many people, Social Security is taxable.
So how do you tell if your Social Security is going to be taxed? Here’s the quick and dirty way to figure it out. First, take half of all of the Social Security income you get and add that to all of the other income you get. If you’re single and the amount is over $25,000 you’ll start getting hit with tax. If you’re married filing jointly—then you’ll start getting hit at $32,000. If you’re married-filing separately and don’t live apart—then it’s all taxable.
So this can totally mess up your tax rates. For example—let’s say you ‘re currently in the 15% tax bracket and you haven’t crossed into “Taxable Social Security Land” yet, but you’re right on the border. You want to take a really nice vacation and it’s going to cost you $10,000. How much money do you need to take out of your IRA to go on vacation and pay the income tax?
Well, you know you need 15% more for the tax so let’s say you take out $12,000.
$12,000 X 15% = 1800
That means that you’ll have $10,200 for your vacation, right? (12,000 IRA – 1,800 income tax = 10,200 vacation money)
Looks good, except it’s wrong. See, if you’re on that border, then half of the $12,000 is going to go into the taxable Social Security pile. So instead of paying 15% on $12,000 you’re paying 15% on $18,000; that’s another $900 in taxes. ($18,000 X 15% = $2,700 and $2,700 – $1,800 = $900)
Now you don’t have enough money to pay for your vacation. You’ll need to be taking more out of your IRA and then even more of your Social Security will be taxed.
Because taking that distribution makes your Social Security Taxable—your real tax rate is 22.5% instead of 15%.
$2,700 tax divided by $12,000 distribution = 22.5% tax rate
For lots of people, there really isn’t much you can do. If your income is high enough, you’re stuck with your Social Security being taxed and there’s no way out. But for some folks—you can plan ahead to avoid this bumped up tax—or at least try to reduce it. You’ve got to know about the tax though if you’re going to plan ahead for it. If you want help figuring out if your Social Security is taxable, give us a call.
Good question! Starting in 2012, you can put up to $17,000 away for retirement in a 401(k) plan. This figure also holds for people who have 403(b) plans and any of the 457 plans as well. If you happen to be over 50, you’re allowed what’s called a catch-up contribution so you can add an additional $5,500, making your total 401(k) contribution $22,500 for 2012.
Remember, money that goes into a 401(k) is tax-deferred so although you’re not paying tax on the money now, you will pay tax on it when you do withdraw it for retirement. If you take the money out of the plan before you reach the age of 59 ½, there’s a 10% additional penalty on top of the regular tax that you’ll pay. As much as I think 401(k) plans are a great deal, if you think that you’re going to need the money before you retire, you might want to re-think your contribution.
A good rule of thumb is that a person should be contributing 10% of his or her income into a retirement program. If you can afford 15%, that’s better, but 10% for sure.
Some companies have what’s called a Roth 401(k)—it basically works like a Roth IRA: you pay your income tax on your retirement plan contributions now, but when you take the money out later it’s tax free. Roth 401(k) plans have the same limits as regular 401(k) plans. If you have access to one of these plans you should seriously consider using it. For anyone who is in a 15% or lower tax bracket, choosing the Roth should be a no-brainer. If you’re in the 25% tax bracket and under 40, I’d still go with the Roth. After that, I’d start doing some serious considerations of what my future plans were, how early I’d want to retire, and other factors.
If your income is below $58,000, you can make fully deductible IRA contributions in addition to your 401(k) contributions (For married couples it’s $92,000.) This gives you some wiggle room. If you’re not comfortable committing to your 401(k) contribution rate, you can make up the rest with an IRA if you’ve got the funds at the end of the year.
If you haven’t started saving for retirement yet, this is the time to start.